Tr. Obsido Kevo

"Be fearful when others are greedy and greedy when others are fearful."
"Success in investing doesn't correlate with I.Q. once you're above the level of 25. Once you have ordinary intelligence, what you need is the temperament to control the urges that get other people into trouble in investing."
~~Warren Buffett(巴菲特)

“Price is what you pay, and value is what you get!”
~~Benjamin Graham

「技」壓 群 雄.
「期」謀 戰 略,
「權」傾 天 下.


Previous related posts:
- QE3
- Commentary and view on QE3 – Part 1

Another result that the Fed hopes to achieve is driving investors away from the safety of treasuries, and into riskier assets such as high quality corporate bonds and equities. On the lending front, as the spread between fixed rate loans and floating rate loans narrows, the yield give up for owning floating rate securities is minimal.  Many banks require an interest rate floor on (a long put option from the lender’s perspective) these floating rate commercial loans, as a result, in spite of the treasuries nominal rate might be lowered, the real rates paid on these commercial loans will not go much lower.

The QE3 has a similar effect by allowing the Fed to go into the secondary mortgage market and purchase Agency MBS, the higher demand increases the price of such securities, and thus help lowering the rate, plus the Fed had previously purchased some MBS, as those loans amortize and mature, I believe they will commit the principal and interest proceed to more MBS purchase.  Translation:  lowered mortgage rate and higher disposable incomes for borrowers.  This has a similar effect as Twist 2, except, Twist 2 seems to lower rate on the front end, and QE3 does it through the back end, so to speak.  It is, however, difficult to judge how effective this stimulus is, when there is an overall anemic demand for housing with multi years worth of shadow inventory that needs to work through the system.  This nevertheless, is not what some people worry about, the fact that this Quantitative Easing is not sterilized would result in propping up asset price including Housing price, Business Values, Commodity Price, Food Price, Energy Price, and most recently readily observable, Equity Price, so on and so forth.  There is a good chance the newly created currency may find its way into the circulation and causing inflation(or god forbid Stagflation) to spike.

The spiking of U.S. Dollar denominated asset prices is often accompanied by a drop in the U.S. dollar.  Weaker dollar is beneficial to U.S. Export, and increasing export may attenuate the trade deficit, which supports GDP growth and shifts jobs here, unless the rest of the world does something to counteract the situation.  More likely, in such weak world economy, Central banks of the Euros, Yen, Yuan, and other trading partners of the U.S. are gonna fight back, and this may cause a full fledged currency war, and who knows what that may lead to.


<Previous post about QE3>

The fact that I am not an expert Fed watcher/economist prevents me from having a solid opinion on the size of the QE3; however, I do have some other thoughts and opinions relating to the actions taken.

The continuation of Twist 2, has the intention of artificially creating demand on the longer end of the yield curve, which lower rates on the long end, and the fact that it is a net zero purchase means selling the same dollar amount of shorter term Federal Treasury Bill securities to offset the purchase, thus artificially increasing the borrowing cost at the shorter end.  I wonder what the efficacy would be in the third round of QE3 mainly because, in finance, we have a pretty good understanding of the behavior of consumers in terms of mortgage refinancing.  There are costs associated with refinancing a mortgage either through your local mortgage broker, or directly with a bank.  Such costs inhibit the smooth translation of lowered rate into mortgage refinanced into lowered rate.  Thus borrowers do not refinance purely because the rate is lowered, they must gauge the costs and benefits of such refinance.  Moreover, rate fluctuates, usually those who qualify to refinance, refinance the first time when rate drops, the subsequent rate drops produce much fewer qualified refinancing candidates, unless the rate drop is substantial and refinancing benefits outweights the costs.


On September 13, the Federal Reserve’s Open Market Committee rolled out its latest round of accommodating policy which included more quantitative easing, dubbed the QE3(a third round of quantitative easing).  The policy details were the continuation of operation twist; new purchase of $40 billions worth of Mortgage-backed Securities a month; and continue to maintain low interest rate environment to 2015 and others.

The continuation of the previous operation twist, dubbed Twist 2, is the buying of equal amount of longer term U.S. Treasury bonds or note, and simultaneous selling of shorter term treasuries Bills.  The primary reason is the U.S. housing mortgage lending rate is tied closely to the Ten years treasury note, and other longer dated bonds, than the shorter term treasury bills.  In doing this, the Fed hopes to lower the borrowing cost of getting a mortgage, and thus stimulating housing.  This action does not create new money out of thin air.

The second part of the policy is what many dubbed as the QE in open ended QE3.  The Fed will create new money out of thin air($40 billions a month), and use these money to purchase Agency Mortgage Debt Securities, which is just a big word for Conforming mortgage loans from Fannie Mae and Freddie Mac.  The Fed did not state for how long they will be performing this action, only stating that the Fed will do this for as long as it takes, thus this is deemed open-ended.  In doing the QE3, the Fed wants to again, hit the nail in the head, by further lowering the borrowing cost of mortgage rate, and thus stimulating the housing market.  The Fed did not state if the program is sterilized or not.  The combined purchases as a result of Twist 2 and QE3  through the end of this year would be $85 billions per month.  It is quite obvious in doing Twist 2 and QE3, the Fed believes that propping up the housing market is essential to helping with the current economic recovery.  那裏跌倒,那裏站起來

The third part of the latest policy is the conspicuous, clear and transparent communicating the “commitment” of extending the “ultra low Fed Funds rate accommodation” of 0.0% to 0.25% environment through at least mid 2015, from year 2014 previously.  In doing so, the Fed is hoping that it allows for businesses to plan their spending and investment in a way that is more certain, hoping that businesses will be more willing to borrow, spend and invest.  The idea is that policy and communication transparency assure businesses confidence and certainty; more borrowing, spending and investing by corporate America will potentially stimulate aggregate demand through jobs creation and employment.  The Fed also leaves open the potential of additional assets purchase and deployment of other policy tools as needed.


Forming a target list

After a review of my investing plan, I went back and revisited Warren Buffet’s Berkshire Hathaway(股票代號: BRK-A; BRK-B) business acquisition criteria, that help shaped the basis of my investment criteria.  The fact that we at here, on many occasions, advocate traders and investors to generate a list of investment/trading ideas that one should stick to and follow regularly, the criteria that I am going into detail here can help formed your watchlist.

The following is the acquisition criteria that has been in place at Berkshire Hathaway for a long time, it is “succinct and simple”.  The difference between investing and trading is that, investing requires a very long horizon, patience, and does not usually require week in and week out getting in and out of positions.  The idea is to identify excellent businesses that are temporarily trading at depressed market quotational price, preferably much lower than its intrinsic value, as calculated based on its high certainty future cashflows discounted back to the present with an appropriate discount rate.

The essence of trading is basically the pure capturing of the positive market quotational differences by identifying and following some sort of trends.  Underlying businesses characteristics are of little use relative to the issue’s market price behavior.  Trend analysis are usually achieved by technical analysis, which is useful in identifying short term prominent trends, supports and resistances.  The time frame for trading is usually short, from fraction of a second to weeks or months.  Therefore, options(short and especially long when done properly) are excellent vehicle for short term trading because of the capital requires(leverage).

Catalysts are very important in affecting a significant market quotational change.  Investment at depressed price requires catalysts, also known as the generosity and subsequent agreement of the masses to bring prices back to the appropriate level.  It is similar with trading in this regards that most traders are buying or shorting in anticipation of some catalysts kicking in to realize the significant price  change, it’s just that technical analysts hope to shorten the time horizon with their fantastic tools.  More importantly, it is the “right catalyst” that propel a stock price to behave the way traders expected them to behave.  In this case, that’s why it is important for traders to “stop loss” if the catalyst(s) were wrong or fail to stimulate the price the way the traders envisioned from their technical analysis.  On a more depressing note, the biggest whales such as Buffett, Icahn, Soros and big name fund managers can provide their own catalysts simply because they can make a lot of noises and are watched and followed religiously, while you and I, until we become whales, are at the mercy of others seeing what we saw in an issue.  Please don’t forget about tradeoptions4living when any of you become a whale.

While this idea is not advocated by most financial planner and/or money manager, because investing(the Warren Buffett fundamental/value way) is different from speculation, legendary investor Warren Buffett is very comfortable putting the majority of his fund in one or a few companies.  That is because he does not put a time line in his investments, he simply sits and waits, and lets the price runs its course.  The duration is usually much longer than what traders have in mind, but because he purchased at a price so good that the annual return of his investments usually outperform the broadmarket index.  Long term value investors, after doing their homeworks, do not stop loss simply because of daily market quotation loss, or sell because of a quick gain.  They incorporate the criteria I am detailing here to ensure the investments, or more clearly, the underlying businesses, perform above average for a very long time with high return on capital.  Make sure you do not mix trading with investing by not stopping loss with your long options.  Long options lose time value everyday, and if the anticipated price movement do not occur within your “time frame”, or the movement go against your expectation, one must stop loss.  Because intelligent investing is to avoid permanent capital loss, trading long options by definition is not investing buffett style(due to time value degradation), you must exercise cautions when determining what portion of your capital you should commit for long options speculation.


We are eager to hear from principals or their representatives about businesses that meet all of the following criteria:
(1) Large purchases (at least $75 million of pre-tax earnings unless the business will fit into one of our existing units),
(2) Demonstrated consistent earning power (future projections are of no interest to us, nor are “turnaround” situations),
(3) Businesses earning good returns on equity while employing little or no debt,
(4) Management in place (we can’t supply it),
(5) Simple businesses (if there’s lots of technology, we won’t understand it),
(6) An offering price (we don’t want to waste our time or that of the seller by talking, even preliminarily, about a transaction when price is unknown).

The larger the company, the greater will be our interest: We would like to make an acquisition in the $5-20 billion range.

Criteria #2 is what defines an excellent business.  The crust of investing is defined at Berkshire Hathaway, the transfer of purchasing power to others now with the reasoned expectation of receiving more purchasing power-after taxes have been paid on nominal gain- in the future.

Consistent earning power-A trait only the very best businesses with a certain moat or moats protecting them from competition can demonstrate consistently, simply because in economics above average return on capital attracts competitions, and this tends to reduce the return back to around average.  The very best businesses have characteristics either tangible and/or intangible that help them overcome their competitions.

The fact that future projection is of no interest to Buffett demonstrates the idea that his style on investing only allow this whale to swim in established businesses with great business models, and criteria #5 only stipulate that the business is easy to understand.

Criteria #3 is the definition of good return.  During good time, debt tends to magnify the return earned on equity capital, but debt also enhance the inherent business financial risk.  Do not be fooled by above average return utilizing a large amount of debt, one must check to see if this is a common characteristics among its industry, but even then, beware of high leverage as when the tide of good time is gone, you don’t want to be revealed as swimming naked.

Criteria #5 is very important for the average long term investors.  A simple business that does not require constant innovation can usually operate with lesser working capital than technology intensive businesses.  Or simply put, boring simple business protected by some form of moats that are easy to understand allows long term investor to assess, with relative ease, the long term performance of this business.  This resonates with the idea of circle of competence.  The average joe has a small circle of competence meaning they can understand the simplest businesses the best.  As your investing and business intelligence increase, one can increase his or her circle of competence.  For example, an engineer may know why the technologies at certain high tech firms help contributed to their dominance, and how these scenarios of market dominance may evolve, such idea of business projection may be out of the scope of the average joe but crucial in determining the business future if one can decipher such complications.

Master these concepts, and you are on your way to enhance the quality of the business names you will be following, and actually understand what makes you want to follow these names.


During the past week, Apple(股票代號: AAPL) announced its blockbuster earning, $8.8 billion($9.32/share) vs. $7.31 billion($7.79/share) same period a year ago, a whooping 20% jump.  However, it was below the consensus street expectation of $10.38/share on $37.23 billion in revenue.

As a fundamental analyst, I had an extremely bullish view on Apple’s business, and I wanted to participate in this earning.  I bought September calls a few weeks ago in anticipation of the intensifying IV, and apple’s tradition of earning beat.  My basis were that, the volatility increases should balance out the time decay of an option expiring in about 70 or so days.  News from the media such as the lukewarm launch of the new iPad for China’s apple store caused me to hypothesis that a lot of the Q3 sales of iPad had already been pushed up to Q2, and the quarter’s iPad sales result could be beyond expectation.  Moreover, the expectation of a mini iPad, Apple smart TV, and the new iPhone drove me to be extremely bullish on the stock.

Man, was I wrong, big time.

Mistake #1, I ventured into an unfamiliar territory without the help of technical analysis, I entered the trade when the stock price was peaking at around 620-ish.

Mistake #2, when the stock retracted, and when my loss reached 30%, I did not cut my losses as required by the rule, hoping that it was only temporary.

Mistake #3, I “gambled” and waited for the earning announcement, hoping that my bet would turn out to be right.  IV completely deflated after earning, the stock went down 5%.  My Calls went down from $32 down to about $6.  A loss representing of at least 80%.

Mistake #4, I stuck to my gun of believing in the value of apple I derived through fundamental analysis, but I used the wrong tools, I mixed investing with trading, a deadly combination, a mistake I have made before.

Mistake #5, don’t get emotional, if you are upset, don’t trade, because it can very well turn into a dead end gambling bet.  Don’t gamble money you cannot afford to gamble.

There are probably many more mistakes, but it hurts to write this article and be reminded of all the poor judgement I made.  It is however, necessary and imperative, to face my own demon, my failure, be truthful to myself, and not to believe that I am better than I actually am.  Don’t hide from it, must face it head on.

My dear fellow traders, stick to your trading plan, it takes courage to stop loss, it takes discipline to follow through with your stop loss protocol, it takes guts to admit you are wrong before it is too late.  I hope my painful sharing can serve as a constant reminder to all of you.

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